Question

1. A company issued a bond with a coupon rate of 8 percent that pays annual interest and matures in eight years. The market rate of return on bonds of this risk is currently 11 percent. What is the current value of a $1,000 face value bond? (Use the formula/equation)

2. What should be the Exact and approximate real rate of return on the bond if it provides a nominal rate of return of 6.192 percent at a time when inflation is 3.12 percent? (Show your formula/equation/calculations)

3. Sami wants to earn a real return of 4.3 percent on any bond he acquires. The inflation rate is 2.6 percent. He has determined that a particular bond he is considering should have an interest rate risk premium of .24 percent, a liquidity premium of .0625 percent, default risk premium of .12 percent, and a taxability premium of 1.62 percent. What nominal rate of return is Sami demanding from this particular bond?

Kindly show the formula used to further my understanding. Thank you in advance!

Answer 1

1.

Given,

Face value = $1000

Coupon rate = 8%

Maturity (n) = 8 years

Market rate of return (r) = 11% or 0.11

Solution :-

Annual interest (A) = $1000 x 8% = $80

Current value = A/r x [1 - (1 + r)^-n] + [face value (1 + r)ⁿ]

= $80/0.11 x [1 - (1 + 0.11)^-8] + [$1000 (1 + 0.11)⁸]

= $80/0.11 x [1 - (1.11)^-8] + [$1000 (1.11)⁸]

= $80/0.11 x [1 - 0.433926496] + [$1000 2.3045377697]

= $80/0.11 x 0.566073504 + [$433.9264963]

= $411.68982109 + $433.9264963 = $845.62

So, the current value of bond is $845.62